Over the course of 15 years working as a performance coach with traders and investors, from day trading shops to hedge funds and investment banks, I’ve enjoyed an unusual front row on the factors that contribute to success and failure in financial markets. During that time, I’ve conducted numerous interviews, directly observed hundreds of traders and administered countless personality tests. That experience has convinced me that much of what we think we know about trading success is just plain wrong. In this article, I tackle three myths of trading success and offer alternate perspectives.
In February 2000, a financial advisor named Bob Markman wrote an article that got a huge amount of attention online. Called “A Whole Lot of Bull*#%!” (that’s how the original was spelt) and published by Worth magazine, the article attacked the idea of diversification, arguing that any money put into currently underperforming investments was money wasted. Internet and other technology stocks had been so hot for so long that nothing else was worth owning, Markman argued. He was far from alone in saying that.
Markman and I exchanged long emails and even longer letters (that’s how people communicated in those Neolithic days), but the “debate” boiled down to one point: Can the typical investor predict the future with precision, or not? Markman insisted the answer was yes. I felt then, as I still do, that the answer was no.
In Markman’s defence, there is a case to be made that if you have inside knowledge or superior analytical ability, then you should bet most or all of your money to capitalize on it. Warren Buffett and Charlie Munger have long argued exactly that. If you are as analytically brilliant as Buffett or Munger, diversification will lower your returns. The rest of us, however, should have much less courage about our convictions. And inside knowledge or superior analytical ability are best applied to individual securities, not to broad market views.
Each morning, at around 4:45, I think about what I will write as the subject of my opener for the day.
I typically contemplate the prior day’s market action and the overnight price changes in the major asset classes and regional markets around the world and I try to come up with something relevant, topical and actionable.
Something on my list, for many moons, is the subject of the lessons I have learned from Jim “El Capitan” Cramer.
Over the years I have written about the contributions that Jim has made and I have defended Jim as well against the wrong-footed criticism that he often faces in his role as a high-profile and visible public figure.
My defence of Jim is not done because I essentially have worked for him over the last two decades. Rather, it is heartfelt and done in the recognition of the contributions that Jim has made since he invented and founded TheStreet. I do this in large part because Jim has been my professor, an important contributor to my investment experience.
When you first start to study a field, it seems like you have to memorize a zillion things. You don’t. What you need is to identify the core principles – generally three to twelve of them – that govern the field. The million things you thought you had to memorize are simply various combinations of the core principles.
This extends beyond those learning a new field. I think it’s most relevant for those who consider themselves experts. The root of a lot of professional error is ignoring simple ideas that seem too basic for those with experience to pay attention to.
Having seen the investing world from several different angles, four skills stand out as governing most of outcomes.
1. The ability to distinguish “temporarily out of favor” from “wrong.”
The two strongest forces in investing are “This investment looks broken because that’s how opportunity presents itself” and “This investment looks broken because it’s actually broken.” It’s hard to tell the difference in real time. Distinguishing between the two relies on accurately calculating the odds that something will eventually come along to heal or promote the market or company that looks broken. And since those odds are always less than 100%, it can take a while to tell if you’re any good at it, because even when the odds are in your favor the outcome can go the wrong way. It’s hard to do. But worse, and more common, is forgetting that a distinction needs to be made in the first place.
Here’s a great article from Morningstar which discusses the importance of patience as a value investor. One of the key takeaways is:
“However, by anchoring investment decisions to value, we can navigate challenging circumstances and look through market noise and emotion to identify and take advantage of opportunities that may present in times of market stress. This often sees our views as contrarian to others in the market.”
Here’s an excerpt from the article:
It is difficult to know how long it will take for an attractively priced asset to appreciate towards its fair value, long-term investors must be prepared to wait.
Value investing has a prominent place in our investment process and is backed up by a vast body of empirical evidence that supports this approach to investing.
Perhaps it can be best described through illustration in the diagram below:
This is an oldie but goodie – Peter Lynch on how to pick stocks. By chance, we were also doing the Lynch book list and ran into some confusion if anyone knows please let us know
Here are the obvious three
|One Up on Wall Street||Peter Lynch||1989|
|Beating the Street||Peter Lynch||1993|
|Learn to Earn||Peter Lynch||1995|
The Davis Dynasty: Fifty Years of Successful Investing on Wall Street says its by John; Peters S. Lynch (foreword) Rothchild, I would assume the foreword for a book about Shelby Davis would be the investor Peter Lynch but we were unlear if he had a middle S initial (or if he did not, is that a typo? – obviously can read the book itself but hard to find some of these out of print books and we only have so much time and rsources) in the end we were not sure so would want to exclude it. We will have our list for better or worse soon. We also transcribed the following video – it is not verbatim and is for information purposes only
So much has been written about vicarious learning i.e. learning from mistakes of others. It is humbling to admit that despite all the knowledge out there, I failed to learn vicariously. The purpose of writing this piece is to put down the learning’s (very expensive ones) over the last decade or so. I hope to smarten up in the future though.
Before writing about what did not work, it is important to set the context. There is no best or the right way to invest – investors have successfully generated huge returns from different investing strategies – be it buying and holding quality companies, chasing growth even at high valuations, buying cheap companies betting on turnarounds etc. People have made large amount of wealth by having concentrated as well as diversified portfolio. So investors have to explore what works for them, given their financial requirements, temperament, skill and time horizon.
Two important factors to consider while looking at the mistakes (and lessons) are:
- Allocation strategy: diversified or concentrated. I go with a concentrated strategy so these mistakes are more relevant in that context.
- Portfolio approach: It is important to look at the portfolio return and how the portfolio is structured. This is different from trying to maximize returns from each individual stock.
The major mistakes (with very high opportunity cost) made over the past years:
The fund industry has grown massively in the last 25 years, and it has changed to a better-run, more professional, and lower-cost business, Here are some key lessons for investors:
- Build a plan for multiple investment goals and stick to it.
- Align your investments with each goal.
- Keep costs low, but evaluate whether some services like paying for financial or tax advice are worth the price if you don’t have the time or investing acumen to do it yourself.
- Choose funds that are good bets for five years from now because they have the depth of managers and analysts, low costs, and strong stewardship to keep them on the right path.
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I think we can all agree that habits are what determine our success or failure in any endeavor, trading included. So, how do we go about developing the type of habits that will lead us to profitable trading?
The answer: Routine.
Proper trading habits do not just magically appear out of thin air (unfortunately). They can sometimes take years to form. However, luckily for you, you have the power to put into motion a plan that will bring forth the proper trading habits sooner than otherwise possible. The development of positive habits, the ones that lead to success in any field, is something you can make a conscious effort to achieve simply by implementing consistent daily routines.
Rakesh Jhunjhunwala is widely referred to as the Indian Warren Buffett. The investment maestro is very popular for picking up stocks that could turn into multibaggers, based on his own study of fundamentals and research models. Rakesh Jhunjhunwala is a Chartered Accountant by qualification and a trader by profession.
With the stock markets on fire of late, many investors who could not invest before the bull run began must be wondering if they have missed the rally, for the benchmark indices Sensex and Nifty have already returned about 20% each so far this year. But worry they must not, for, here we take a look at 11 key lessons on the stock market from the big bull investor himself, which may help investors to stop failing in the stock markets, cut losses, and turn profits.